Investors may be hit hard by RCF sale’s lack of disclosure

A file photo of the RCF building in Mumbai. The government sold a 12.5% stake in RCF through the OFS route on 8 March and raised Rs.310.5 crore. Photo: Abhijit Bhatlekar/Mint

Updated: Sat, Mar 30 2013. 11 17 AM IST

Mumbai: The so-called offer for sale (OFS) route, the fastest method of raising money from the public, is helping the government achieve its disinvestment target and private companies meet public holding norms, but some investors may lose out as the quality of disclosure may not always be adequate.

For instance, Rashtriya Chemicals and Fertilizers Ltd (RCF), in which the government sold a 12.5% stake through this route on 8 March and raised Rs.310.5 crore, did not disclose details of a key risk factor, which it had raised with its parent ministry six months earlier.

The state-run fertilizer company had written to the ministry of chemicals and fertilizers that it would make losses unless a government decision taken in February 2012 to withdraw supply of domestic natural gas to its non-urea fertilizer producing unit, along with those of other fertilizer makers, was reversed.

Mint has reviewed a copy of the letter.

This decision on natural gas was made by an empowered group of ministers (eGoM) chaired by then finance minister Pranab Mukherjee.

The eGoM had decided that domestic gas should be made available only to urea manufacturing units. It also directed that any excess profit made due to the use of cheap, domestic gas for production of non-urea—or ammonia, potassium and phosphate-based—fertilizers be recovered.

While the eGoM’s decision was reported in the media in February 2012, RCF’s view on its consequences for the company isn’t in the public domain.

Unlike the follow-on public offer (FPO) route, in which a listed firm has to file a red herring prospectus and the final offer document must contain detailed explanations of the risk factors and contingent liabilities, no such dedicated prospectus is needed for an OFS.

The OFS route was created by the Securities and Exchange Board of India (Sebi) in January 2012 to help companies increase their public float and raise funds fast, at a time when equity markets were choppy and not too many initial public offerings were in sight. It functions like an auction, where investors bid based on the floor price, and if successful, they are allotted shares. The entire transaction is carried out in a day.

The notice that precedes such an OFS transaction states that since the company does not intend to make a public offer of the shares on sale, no documents are prepared or submitted for approval as a prospectus or an offer document. It also says that bidders acknowledge that they are bidding for the shares on the basis of publicly available information.

But there are instances in which associated risk factors have not materialized and hence their implications aren’t publicly known.

An investor presentation posted in February on RCF’s website said factors such as “fluctuations in global raw material prices and natural gas prices”; “high cost of domestic gas/shortage of gas”; “stringent terms in gas supply and transportation contracts and their operability”; and “policy related issues” were key business challenges, but does not elaborate on them.

RCF did not respond to an email sent on 14 March seeking comment.

The 26 September letter to the ministry by RCF executive director (finance) R.H. Kulkarni said the eGoM’s decision would “make operating the Trombay unit (RCF’s facility in Mumbai) unviable”.

The company contended that it was the government that had directed its Trombay unit to switch to gas from naphtha. It also said the unit was a single integrated entity where the use of ammonia for manufacture of urea, non-urea fertilizers and intermediate chemical products weren’t “self-balancing independent trains”. Therefore, it isn’t possible to identify which portion of the gas is used for purposes other than making urea, RCF said.

The letter said that if domestic gas allocation was withdrawn, RCF would have to switch to imported natural gas, the landed cost of which it estimated at around $16 per million British thermal units, 166% more than that of domestic gas. “The negative impact on the profitability of the company would be approximately Rs.569 crore per annum, which cannot be passed on to customers,” the company said.

The only option then, according to RCF, was surviving solely on the production of urea. If this happened, the company would make a loss of Rs.114 crore a year and would have to make a one-time impairment provision of Rs.442 crore, “which will erode net- worth substantially”, RCF said.

The letter, written in response to a ministry note seeking the company’s views on the eGoM’s decision, requested the department of fertilizers to take up RCF’s case with the eGoM and seek a reversal of its decision.

The matter is still pending and fertilizer companies affected by the decision are pushing the ministry to seek a review of the eGoM’s decision on their behalf.

“LIC was not aware of this risk factor before investing in RCF’s OFS,” said an LIC official, speaking on condition of anonymity. “LIC only had that information which is in the public domain. This particular information is neither in the public domain nor in the media. The company should have made fair disclosures before the issue.”

State Bank of India (SBI), another investor, relied only on publicly available information before investing. “In an OFS, a company is only required to disclose minimum information as prescribed by Sebi,” an SBI official said on condition of anonymity. “The notice for the OFS was filed on the National Stock Exchange and it came to all investors. Based on that, we subscribed to their issue.”

A person close to Sebi’s policymaking process said RCF’s letter to the ministry appeared to contain material disclosures. He didn’t want to be identified.

“A listed firm not disclosing such a risk factor at least before a share sale, if not during a normal trading day, may be incorrect as per listing agreement norms,” this government official said. “It is logical that OFS regulations should require a company to disclose such risk factors before launching the issue.”

An email sent to Sebi on 22 March didn’t elicit any response.

Amit Tandon, founder and managing director of Institutional Investor Advisory Services, which offers consultancy to minority shareholders, said that in RCF’s case, it needs to be determined whether the nature of disclosures in the company’s letter is such that they would need to be incorporated in the offer document had it gone for an FPO. If so, it was a “serious matter”, he said.

Since 29 February 2012, the first trading day after the eGoM’s decision to cancel gas allocation to non-urea fertilizer makers was reported, RCF’s share price has lost 45.58% on BSE, while the bourse’s benchmark S&P BSE Sensex index has gained 6.23%. The S&P BSE PSU (public sector undertaking) index lost 16.27% during the same time.

On Thursday, RCF’s share closed at Rs.36.60 on BSE, up 2.81%, while the Sensex gained 0.7% to end at 18,835.77 points. The floor price of its OFS was Rs.45. The market was closed on Friday.